Economic Logic, Too

About Me

I discuss recent research in Economics and various events from an economic perspective, as the name of the blog indicates. I plan on adding posts approximately every workday, with some exceptions, for example when I travel.

Monday, October 31, 2011

I have never been fond of the claims that the world is better with religion. The principal claim is that religion gives hope for people in dire circumstances, and thus in Economic terms increases their utility despite having hit the budget constraint. But one could also argue that these people are being mislead, as religion provides them with subjective probabilities that are far off the objective ones, all the while making the budget constraint even tighter because of the tithe and other material donations.

Olga Popova studies whether this effect of religion on happiness not only applies to individual circumstances, but also for aggregate shocks. Looking at the transition countries, which each suffered through substantial falls in GDP after the collapse of the Soviet rule, more religious people suffered, in terms of happiness, less than others from the large economic reforms. Of course, it is easy to understand that for most, they were happier than circumstances would indicate because it was rather obvious that things would eventually improve, likely a lot. The question is why religious would believe this more? Because they are easily indoctrinated, and it is certainly true that there was a lot of excessive pro-market rhetoric at the time. Non-religious people were probably more among the skeptics. And they were also more likely to be among those who benefited from the previous regime, which definitely oppressed religion. Unfortunately, this study does not take (previous) party affiliation into account, which is likely very (negatively) correlated with religiosity. Too bad.

Friday, October 28, 2011

What makes a good college students? Looking at the admission criteria of universities can be insightful. Public universities in the United States basically just look for high school grades and standardized test results, with some adjustment background characteristics (race, high school characteristics), if any. European universities in the end just care about grades, in most cases that a student was above some level. And US private universities look at a large array of characteristics, with extracurricular activities and personal essays being of particular importance, grades in some cases being even ignored. While these different types of universities have obviously different motivations, ultimately they are looking for potential in students. So what determines academic success?

Martin Dooley, Abigail Payne and Leslie Robb use administrative data about a dozen entering cohorts in four Ontario universities to explain what makes students stay longer in tertiary education and have better college grades. It turns out that the high school grades are pretty much sufficient. At least for Canada, it is reassuring to see that individual performance matters more than where you are coming from. Of course, one could wonder whether all the other characteristics that private US schools consider would matter here. But this kind of data was presumably not available, as Ontario universities, all public, do not ask for such information during the application process. Also, there is no record in the study about individual standardized test results. Including those would only reinforce the results, but may have important policy implications: imagine they do not matter. Then it opens the door to grade inflation in high schools, and the grade signal gets diluted. And then admissions officers need to find something else to rely on, such as some of the characteristics that matter less.

Thursday, October 27, 2011

I always feel small talk has no specific purpose and is a waste of time. In fact, every time somebody asks me how I do, I launch into a well reasoned explanation of my current state of affairs, while my intelocutor is just expecting a "well-thanks-and you?" Yet, some people have found value in such chitchat, see a previous report. But what about contracts that have clause that have no chance of being met? Why would one allow empty promises in a legally binding contract?

David Miller and Kareen Rozen look at contracts that involve team work in a complex production environment, where opportunities for moral hazard abound. Performance clauses are hard to specify and you want to use peer monitoring and pressure rather than checking for the result of each individual task. Obviously, monitoring is costly, and along with statistical complementarities in the success rate, this implies that it could be optimal to delegate all the production to one person and the monitoring to another (the least productive one, according to the "Dilbert Principle"), and the latter may resort to wasteful punishment: naming and shaming, and even firing. It is wasteful, because it does not provide any direct benefit to the supervisor and it may not even be subgame perfect. Where are the empty promises? The one performing tasks can promise to fulfill them, but it obvious to all that they cannot be all successful because of some outside probability of failure. But the supervisor is willing to forgive failures, without knowing whether chance or moral hazard are at play.

Wednesday, October 26, 2011

The great thing about the Internet is that one can discover unexpected uses of familiar techniques. Or one can search for new applications with one's tool set. So what about SUR and lamb carcasses?

Vasco Cadavez and Arne Henningsen are responsible for this paper. I have nothing to add to the abstract: The aim of this study was to develop and evaluate models for predicting the carcass composition of lambs. Forty male lambs of two different breeds were included in our analysis. The lambs were slaughtered and their hot carcass weight was obtained. After cooling for 24 hours, the subcutaneous fat thickness was measured between the 12th and 13th rib and the total breast bone tissue thickness was taken in the middle of the second sternebrae. The left side of all carcasses was dissected into five components and the proportions of lean meat, subcutaneous fat, intermuscular fat, kidney and knob channel fat, and bone plus remainder were obtained. Our models for carcass composition were fitted using the SUR estimator which is novel in this area. The results were compared to OLS estimates and evaluated by several statistical measures. As the models are intended to predict carcass composition, we particularly focused on the PRESS statistic, because it assesses the precision of the model in predicting carcass composition. Our results showed that the SUR estimator performed better in predicting LMP and IFP than the OLS estimator. Although objective carcass classification systems could be improved by using the SUR estimator, it has never been used before for predicting carcass composition.

Tuesday, October 25, 2011

IP addresses face exhaustion, at the least those under the standard IPv4 format, and by some reports they should have been all used up already. What has helped delay the inevitable is probably the fact that there is now a market for IP addresses, yet it is not clear that the market is working efficiently. The reason is that IP addresses are allocated in blocks, and fragmenting the big IP allocation table makes it more difficult to manage it. For technical reasons, each allocation needs to be a square in the table. Thus, if a square is partially unused, it can only be split in multiple squares, increasing their number. Routers need to keep each possible square in memory, and their multiplication slows routing. And as IP addresses are privately owned and managed, there is no way to control this negative externality.

Benjamin Edelman and Michael Schwarz propose a market mechanism that should make the allocation of IP addresses more efficient. They suggest a "spartan rule:" in each bilateral trade, one of the two traders is designated as "extinguished," i.e., as prohibited from trading with other extinguished ones. As one can be extinguished only once, this implies that the number of cuts N in the IP table is limited to the number of initial holders of IP blocks. The analysis is static and under certainty, implying that the implicit rental price of an IP is zero as long as there is still a free one. But with the proposed rule, I do not see how one could necessarily reach exhaustion after the N cuts. It all depends on the initial allocation: one can end up with free IP addresses and no possible moves. In addition, once we add uncertainty and dynamics, there is going to be strategic behavior as being extinguished is a potentially costly absorbing state. I am thus not convinced of the arguments in this paper.

Of course, the easiest would be for everyone to switch to IPv6, which would give a sufficient number of IP addresses to last for a long time. But IPv6 devices cannot communicate with IPv4 devices (large scale IPv4 to IPv6 translation is cumbersome), which gives little incentive to switch until there is substantial critical mass. In other words, another situation like Y2K is approaching, and nobody has an incentive to do something about it. The more efficient market allocation will delay this, but also will make it even more urgent when it happens, because more addresses will need to switch, and they will have less time for it.

Monday, October 24, 2011

Girls (and women) tend to hang out in cliques, while boys (and men) tend to be more individualistic. This may have evolutionary origins. as women try to have have very good friends to insure that their offspring is taken care off should they die. Men do not directly have such a need, and may have several wives who continue to take care of their offspring should the man die. Does this attitude translate into the workplace?

Peter Kuhn and Marie Claire Villeval conduct a experiment where people need to exert effort, but can do it by choice individually or in a team. Women are then more likely to choose the team. Once there is an extra reward in efficiency for working in a team, both genders choose the latter in equal proportions. Still, the most able players tend to work alone. This can be interpreted as men being more responsive to incentives and women having more confidence in team work. Unfortunately, the study does not differentiate between same-gender and cross-gender pairings (gender was visible in the experiment).

Friday, October 21, 2011

The current talk in Republican circles is that one can achieve significant job growth by deregulating. One may want to question this idea on two fronts. First, regulation has been initially imposed not for the fun of killing jobs, but because it improves the well-being of people. There is a trade-off, and sometimes it is worth having a little fewer jobs if it means improving the life of a lot of people. Second, the job loss numbers from regulation are often more fantasy than reality.

This is not a new question. Take the case of Australia, as discussed by Bruce Chapman. He looks at estimate of job loss in Australian mining from the implementation of an emission trading scheme. These 23,510 lost jobs are not as large as they appear. First, there would be job gains elsewhere, in particular in alternative energies. Second, when compared to normal job flows in the mining sectors, this number is quite negligible. Third, once you look at a somewhat longer horizon, say, ten years, a job loss is virtually undetectable. I would add finally, measurement of jobs losses has high uncertainty, and any result commissioned by one party in the debate needs to be taken as an extreme value.

So, do not have too high hopes that a sudden deregulation will create a job boom, especially in a country that has remarkably little regulation to start with.

Thursday, October 20, 2011

Family-owned businesses have good reputation with the public, for reasons that have never been clear to me. Indeed, it is even good marketing to mention that a firm is family-owned. Why? The products are not likely to be better. I suppose such firms are possibly smaller and younger, thus the likelihood of a product to be discontinued is higher. I guess such firms have stronger ties with the community, in case this matters.

Andrea Bassanini, Eve Caroli, Antoine Rebérioux and Thomas Breda find that there is an important distinction between family-owned business and other privately-owned ones. Looking at France, they observe that they pay there workers less, which does not seem like a big advantage in the public eye. However, families tend to offer more job security. This mirrors the public sector that in the end offers the same value as private enterprises, trading off job security and pay. So after all, family-owned are more involved in the community by providing more insurance to workers through job security, like so often the French government does by pursing rather Keynesian policies. I wonder whether this would apply to other countries where the public sector is not necessarily leading with such policies.

Wednesday, October 19, 2011

Oil price fluctuations seem to preoccupy people less these days, maybe because they got used to higher prices or because other issues are hotter now. But remember how popular it was to call for the government, whatever the county, to reduce fuel taxes to ease the burden. Which bears the question whether this would be a good idea if you think harder about it.

Helmuth Cremer, Firouz Gahvari, and Norbert Ladoux did so and come to the conclusion that the fuel taxes should not move as much as the energy price. The reason is that the Pigovian motivation for imposing them, internalizing the externalities, has not changed, which would call for perfect smoothing. But this is to an important extend compensated by redistribution considerations as goods using energy are used by people of different incomes. In the end, a doubling of pre-tax energy prices lead to a post-tax increase of 64%. But that is only assuming that the tax was optimal to start with. In many countries it is currently much too low, thus the argument about reducing the tax in high price times is largely invalid, In fact, one should take advantage of reduction in world energy prices to increase the taxes, which would raise much needed money.

Tuesday, October 18, 2011

The insurance market is thought to be rather competitive, at least for the most common risks. That is in part because insurance companies are willing to take risks thanks to re-insurance, where they can insure large event risks and to some degree over-exposure. But there are rather few actors on the re-insurance market. Is this bad, and does it have an impact on the insurance market?

Sabine Lemoyne de Forges, Ruben Bibas and Stéphane Hallegatte play with a model of re-insurance and find that there is a trade-off. The lack of competition leads to sub-optimal re-insurance provision, obviously. But is also allows the few players to take on larger risks, some of which may not have been insured otherwise. And, the larger the re-insurers, the more resilient the market can be. As a regulator, this means that means that you may to let the re-insurance companies grow larger than want is optimal in terms of competition.

Monday, October 17, 2011

There is talk that Spain could get dragged into a financial crisis. While it is debatable whether this will happen or not, and whether it is inevitable, it is instructive to study Spain's economic history in this regard.

Concha Betrán, Pablo Martín-­‐Aceña and María Pons look at a century and a half of data and basically do in more details for Spain what Carmen Reinhardt and Kenneth Rogoff did for many countries in their best seller. And as the latter book, the picture is depressing. Crises of all sorts were a rather regular occurrence, we have been just blessed with rather few of them over the last half century. For example, in the second half of the 2oth century, Spain experiences half a dozen currency crises, a couple of banking crises, three periods with negative stock returns over several years, and the IMF had to intervene three times for a debt crisis. It takes from this that while crises are becoming less frequent, they still occur, and the current one was long overdue.

Friday, October 14, 2011

Europeans have struggled for some time to understand the philosophy of the US Republican party, and especially how it manages to get such popular support in the electorate. On the surface, indeed, it all appears to be a platform that favors the rich at the expense of the more numerous poor, the latter having been indoctrinated for many years that governments are bad and, at the extreme, robber barons are better than a benevolent government. The consequence is a drive to increase inequalities in income and wealth.

John Roemer offers a glimpse into the American ideology for inequality. He says that "American philosophy" sees inequality as ethical, as it gives everyone what nature endows him with. That seems like a very fatalist argument (as in some religions) that ignores that redistribution is about the ex-post insurance of where someone is born. having the luck to be born in a good family and in a good country ought to be taxed to some degree to benefit the unlucky. A second argument is the old trickle-down one: if the most talented can keep all the fruits of their labor, they will work more (never mind decreasing marginal utility of consumption and how redistribution can improve global well-being). The third argument is that the government is good at nothing, and should thus be largely absent.

All these arguments are largely shared in the United States, and especially among Republicans. In fact, the latter are now going much farther in reversing redistribution than ever before. Just see how they they are vehemently opposed to any risk sharing through public health insurance, how they limit school funding and public goods in general. In fact, I am starting to wonder whether the hidden goal is to create a new underclass that would be in some ways reminiscent of the old slavery days. That would be consistent with the opposition to minimum wages, with the large prison population, and with keeping the poor uneducated. That would also be coherent with the Republicans willingness to increase the payroll tax (a flat tax applicable to everyone) while calling for a reduction in the income tax (a progressive tax). I hope I am wrong, though.

Thursday, October 13, 2011

I have always found the Caribbean fascinating because it is a microcosm of the world, with tiny countries trying to get a workable government without the economies of scale the rest of the world enjoys. But as a readers of Economics research, the presence of this myriad of too-small countries lead to many frustrations, as they bias results in cross-country regressions. But sometimes, these micro-countries can be useful for research.

Roland Craigwell and Alain Maurin use them to study whether there is convergence in the Caribbean. It is well established that there is no convergence on world-wide country data, but it is very visible on subsets, such as US states. In the later case, all US states are under the same currency and roughly the same laws and government systems, there is some cross-state redistribution and no trade barriers. As you drop these features, which one gets you lack of convergence. In the case of the Caribbean, there is a partial monetary and trade union, laws and governments are more dissimilar than in the US and there is no redistribution. And as Craigwell and Maurin show, that is sufficient to make convergence disappear. Once more, it looks like once more institutions and to a lesser extent globalization are the keys to development for the poorest economies.

Wednesday, October 12, 2011

GDP equals C+I+G+X-M. It also equals national income, at least in theory. But estimates differs widely, even for the United States, which is rather disturbing. How do you conduct proper economic policy when estimates of GDP, even after revisions can differ by more than 2% points and their growth rates have a correlation coefficients of only 0.63 (see the work of Jeremy Nalewaik)?

Boragan Aruoba, Francis Diebold, Jeremy Nalewaik, Frank Schorfheide and Dongho Song make the old diversification of risk argument: why not combine both estimates? After all, this is often done with forecasts, and the two estimates can be treated like forecasts of the true GDP. And consistently with this literature, the weights on each should depend on the variance of the errors. Of course, they are not observed, but the authors have some guesstimates, based on correlations with variables not used to construct either GDP measure that are supposed to be correlated with the true GDP. They then show that measurement matters, for example in dating business cycles. We'll see whether the US will adopt such averaging, as some other countries already do.

Addendum: I wonder how the recent major revisions to US GDP would have fared with this scheme.

Tuesday, October 11, 2011

When we teach about how the Internet has improved the efficiency of the economy, one typical example we give is about job search: the Internet makes vacancy postings instantly available and searchable. And job applicants can send CVs with little cost and time, or even have them available in CV banks. The problem is that Peter Kuhn and Mikal Skuderud have proven that this is not true. But that was with data from 1998-2000. What about today?

Peter Kuhn and Hani Mansour replicate the exercise, but with data from 2008-2009. They concentrate on young job seekers and find that those who use the Internet for job search reduce their unemployment duration by 25%, which is considerable (and makes us teachers prescient). And this is not just because of a particular group or specification. Running the same regressions in the earlier sample provides no noticeable effect. This means that somehow people have learned to use the Internet effectively, which is consistent with the success of the Monster Board or Craiglist and the proportion of those using the Internet for job search.

Monday, October 10, 2011

One can count on Gilles Saint-Paul for innovative research topics. During his career, he has addressed and impressive array of topics that range far beyond Economics strictu sensu. For this reason, I have reported several times about his latest research.

His latest opus is an introspection in our profession and how our political biases influence our modelling choices. He claims that an economist with conservative inclinations will favor a model with smaller fiscal multipliers. While the ethical thing to do would be to be driven by empirical evidence, this may just be a subconscious choice. But at least economists strive to be logically consistent, and if one choose a large multiplier, then then must also claim that demand shocks are substantial, as models with large multipliers rely on this. Looking at evidence from the Survey of Professional Forecasters, Saint-Paul finds that forecasters who believe that expansions are more inflationary also adhere to the belief that public expenses are less expansionary.

Saint-Paul goes further, though. His claim is that we live in a self-confirming equilibrium. We devise theories to understand our surrounding and take decisions, and those decisions then shape the economic environment. Theories can thus survive even if they deviate from the true structure as long as the decisions make it conform. This is a statement about a lack of uniqueness of the path to the rational expectations equilibrium. In a sense, this is not too disturbing, as long as decisions are still optimal and outcomes do not differ too much from the rational expectations first best. And if this true, we will never know what the rational expectations first best is. Of broader implications would be if the political agenda of an economist would lead an economy on an different path, on a different self-confirming equilibrium. Is this why Europe and the United States are different? Were Keynes and von Hayek that influential?

Saturday, October 8, 2011

Monday, the next "Nobel Prize" in Economics will be announced and everybody is playing a game of predictions, so why not me? I have a wish that happens to coincide with my prediction: William Nordhaus.

Why? Because environmental economics has been long rumored to get it and it deserves to be recognized. Within that field, Nordhaus has made major contributions that brought this field to the mainstream. And he is a genuinely good guy, always helpful and willing to listen to you or help you out. Also, the signals I have been receiving from members of the Prize committee is that they really like his work.

I am afraid, though, that he may have to share his work with Martin Weitzman. Who has made the more seminal contributions to the field can be discussed, but Weitzman is all the opposite in terms of attitude. In addition, I do not like his way of trying to make a name of himself, like I showed previously. He has also been caught and punished for stealing horse manure, so his ethical standards are definitively not up to par.

Friday, October 7, 2011

For all the justified criticism one can have about the work of Karl Marx and the economic system that resulted from it, old Karl was onto something. The Industrial Revolution saw the rise of a new class, the capitalist, that generates a smaller share of its income from manual work and instead uses its brain and capital. That is in terms of welfare a positive evolution, were it for the fact that workers hardly had it better compared to their previous agricultural life and thus did not get a share of the new riches. What especially irked Karl Marx was the lot of the workers could not improve, either because they were not getting a larger share of income, or because there was no path to become capitalists themselves in large numbers, something later termed as a lack of social capilarity.

Jørgen Heibø Modasli finds some of these features in a model inspired by the Solow growth model, augmented by incomplete markets that require that one cannot borrow to become a capitalist entrepreneur and that the entrepreneur can only work for himself. This introduces a non-convexity and quickly a two-class system emerges, with workers not having any reason to save much as they have no chance to become capitalists. Also, the class division persists over time, even when credit and capital markets improve.

Yet, this is not entirely convincing. Indeed, economies with less incomplete markets, say, the United States, should see less inequalities, and inequalities should have declined over time as markets developed. This is hardly what we can see in the United States, where access to credit is widespread, yet income inequalities are high and growing, and social capilarity is largely absent.

Thursday, October 6, 2011

When you think about leisure in the utility function, for most applications you need to take a stand on some properties: is the income effect larger than the substitution effect? Is leisure a normal good in the first place? Convincing empirical evidence is surprisingly difficult to find: read the endless debate between microeconomists and macroeconomists about the size of the wage elasticity. This may be an aggregation issue, but maybe we are lacking a clear natural experiment.

Naci Mocan and Duha Altindag report on an interesting change in the way members are paid in the European parliament. Whereas previously they were compensated at wildly different levels by there home countries, since July 2009 they get money according to a uniform rule: 38.5% of a European judge's salary as a base, plus a per diem when present. Mocan and Altindag then use the difference between and with the previous schemes to highlight that an increase in the base reduces attendance (yes, the income effect! Leisure is normal!) and an increase in the per diem increases attendance (the substitution effect is larger than the income effect). Politicians are rational after all.

Wednesday, October 5, 2011

Insurance suffers chronically from the problem that only bad risks want to get insured, which makes the cost of insurance prohibitive and the insurance market often collapses while its presence would be a clear welfare improvement. A workaround is to force everyone to participate, thereby avoiding that good risks could weasle out. This is the principle behind health insurance mandates in most of the Western world, and it is part of the so-called Obamacare. But such mandates are difficult when there is a large informal economy, as it makes difficult tracking people, especially if access to government services, paying taxes, etc. are the way the mandate is enforced. Could in fact a mandate increase informality?

Reyes Aterido, Mary Hallward-Driemeier and Carmen Pagés look at Mexico and ask a somewhat different question, but it is still informative: Does the provision of health insurance to those without social security (mostly informals) increase informality? They find the formal sector decreased by 0.4 to 0.7% points because fewer people join it. It is not surprising that fewer people see the need to be cover by social security and thus declared their jobs, yet I find it interesting that the effect on formality is so low in a country where it is so easy to disappears from the books. Transpose that to, say, the US, where having a job is currently pretty much a requirement for health insurance coverage. Would then a health insurance mandate lower the incentive to have job? Most likely yes, but seeing how small the impact was in Mexico and considering that the lower elasticity of the formal/informal margin in the States, that effect is very likely to be very small.

Tuesday, October 4, 2011

In difficult times, it is easy to blame central banks for everything. Part of their role, after all, is to play the scape goat for policies the politician do not dare implementing. But then, there is only so much the central banks can do, as Europe and the United States no "nicely" show now. A substantial ingredient in the blame game is a call for a return to the gold standard, a nostalgia for supposedly better and easier times.

Olivier Ledoit and Sébastien Lotz echo this call and study what our current understanding is about the coexistence of fiat and commodity money. In principle, we can start from the idea that currency competition is good: this would force the central bank to be more careful with its fiat money. Indeed, we have learned from money search theory that bad money does not necessarily chase good money (the old Gresham's Law). Also, if the commodity has a positive return, its monetization is beneficial as long as its storage and transaction cost is sufficiently low. The question is then on how to find a commodity that has a real return from just sitting there. There is a larger problem, though, with small denominations. How do you mint coins measured in cents when the commodity is, for example, gold? Either the coins need to be very small or they have very small commodity content, to the point that they become ... fiat money. Monetary policy also becomes tricky, as quite obviously temporary easing becomes difficult if it risks driving fiat money out.

But in the end, isn't a commodity like gold only valuable because people believe it is valuable? Gold, to take an extreme and popular case, has little intrinsic value, as I argued before, and is thus just another fiat currency. It is all a question of perception.

Monday, October 3, 2011

We are living interesting times in terms of macroeconomic policy: the world faces big shocks and substantial challenges, and many current circumstances have no historical precedents. This means that policy makers cannot draw from experience and need to invent new policies from somewhere better than their guts. And after a few hesitations, theory is now in much better shape to answer questions from policy makers. For example, what should one do when there is a liquidity trap in a globalized economy, especially if the trap itself is globalized?

David Cook and Michael Devereux show how, and it borders on a political miracle. Not only does one need to get the cooperation of fiscal and monetary authorities (something the US is not close to achieving) but one needs the cooperation across countries even if it entails some costs to the "winners" (something the Chinese have so far refused and the Swiss recently abandoned).

Specifically, Cook and Devereux show that with so many countries currently with negative real interest rates, we have a worldwide liquidity trap. In an open economy, the policy prescription differs from a closed economy. If there is a negative demand shock, fiscal policy needs of course to raise aggregate demand, but with a global economy, this can come from anywhere in the world and thus a coordinated fiscal policy is due. But to channel the impulse to the relevant countries, monetary policy coordination is necessary to raise interest rates in the foreign countries, even if they are in a liquidity trap. And this takes some serious courage. One can always dream.